How Common Men Can Pick Stocks?

Stocks are good investment for common men? How common men can pick stocks?

Stocks are good investment for anyone who knows how to deal with it.

How to deal with stocks? By developing a skill which helps in picking good stocks.

How to pick good stocks? Here, the picking strategy varies.

The variation in picking strategy, can be broadly classified into two main categories:

1. Holding Time.
   • Short term.
   • Long term.
2. Risk Taken.
   • Low.
   • Moderate.
   • High.

This brings us to an important question, which stock are good for common men?

But before that, lets understand what I mean by common man in the context of investment?

• Somebody who does 9-6 job/work.
• Core expertise is not finance.
• Has a heap of financial goals to meet.
• Want to invest in stocks, but does not know how to deal with it.

This article is written for these people.

Who is writing this article?

An expert? Not even close.

So why the reader must believe his writings?

Because what is being shared here are wisdom of the great Benjamin Graham.

In his epic book called “The Intelligent Investor”, Benjamin Graham proposes these stock picking rules for a “defensive investor”.

In Chapter 5 & 14 of this book, Benjamin Graham formulates a strategy of stock picking for defensive investors.

I personally feel that common men must venture into the ocean of stocks with a defensive frame of mind.

After they get their feet wet, more enterprising risks can be taken. But before that, it is advisable to remain defensive.

Which stocks are good for common men?

Good stocks are one which can be held for long term without bearing too much risk.

In short term these stocks may show inconsistent growth (volatility), but in long term they will only grow.

As the growth in long term is almost certain, such stocks are said to be of “low risk”.

What makes these stock particularly unique for common men is, people can buy them and forget about it.

Yes, what common men shall do are the following:

1. Identify a good stock.
2. Buy a handful of it.
3. Forget about it (stay invested for next 10 years).

If it is so easy, why everyone is not doing it? There is a big limitation here.

What is the limitation?

How a common man will identify good stocks from a plethora of average ones.

This is what will be discussed in this blog post.

How common men can identify and pick good stocks?

What are good stocks?

Good stocks are one which has potential to generate high returns in long term.

What means by high returns? Which beats the average inflation rate during that period.

Suppose one bought stocks of HDFC Bank in Aug’2008, and held it till today (10 years).

In last 10 years, the stocks and inflation data are as below:

• Stock Price in Aug’2008: Rs.255 /share.
• Stock Price in Aug’2018: Rs.2,077 /share.
• Price Growth Rate (CAGR): 23.3%.
• Average inflation in last 10 years: 7.67%.

As price growth rate (23.3%) is more than average inflation in India (7.67%), the stock can be said to be good.

So does it mean that common men can pick stocks based only on past returns?

No, this may lead to a major error in judgement.

It is also important to pay the right price to buy stocks.

Consider this for an example.

Suppose another person bought stocks of HDFC Bank in Aug’2008 @Rs.1,000 and held it till today (10 years).

What would have been his returns today? 7.5% CAGR. This is less than the average inflation in last 10 years.

What is the point?

The point is, the same stock can prove to be a good and bad buy, based on the price that was paid for it.

The lower one pays for a stock during its purchase, higher will be the profit.

How to ensure that stock price will grow over time?

To ensure this, one will have to take care of few basic stock picking rules during its purchase.

Rule #1. Keep stock portfolio diversified.

Here the rule is, one must not put all money in one stock.

What must be done is to spread the money in many stocks. How many?

According to Benjamin Graham, one must have at least 10 different stocks in ones portfolio.

Too much diversification is also not good. Upper limit should be maintained at 30 nos stocks.

What it means by different stocks?

Stocks of different sectors can ensure portfolio diversification.

Frankly speaking, in today’s world, all sector are somewhere related to each other.

But still, one must always try to maintain a balance of sectors in ones portfolio.

Which sectors we have in India?

According to economic times, there are 23 main sectors in India. This is the list. It has been ranked in order of decreasing market capitalisation.

Rule #2. Include stocks of large companies.

What are large companies? Top 3 companies of the sector.

These are companies which has the biggest market share in its sector.

Why Benjamin Graham consider stock of these companies good for common men?

Because the size of the company gives it an edge over its competitors. What gives large companies its edge?

• Penetration into the market.
• Faithful customer base.
• Set infrastructure.
• Established technology.
• Experienced & skilled manpower.
• Large equity base.
• Easy access to cheaper debt.
• Establish EPS history.
• Establish Dividend payment history.
• Etc.

How large companies are good for common men?

Over a period of time, such companies are most likely to grow at rate faster than inflation.

Rule #3. Include stocks of companies which pays consistent dividends.

What should be the criteria?

According to Benjamin Graham, the company should have paid consistent dividends in last 20 years.

He formulated this parameter based on US stock market which is operational since 1900’s.

But Indian stock market is not so old.

So I would like to add a deviation suitable for Indian scenario.

I like those Indian stocks which paid consistent dividends in last 10 years.

If the dividend also grew over time, it will be like icing on the cake.  

Why dividend paying stocks are considered good? Because consistent dividend disbursement signify two things:

• The company has a healthy cash balance (is liquid).
• The company is sure of its future cash flows.

A company which has good cash balance, and has an assured future cash flow can said to be fundamentally strong. 

Rule #4. Never overpay to buy stocks. Limit the price of purchase.

If one can know the right price that can be paid to buy a stock, half of the stock puzzle will be solved.

There are two puzzles to be solved in stock investing:

1. Which company is good?
2. What is the “right price” to pay for its stocks purchase?

A professional stock investor know how to estimate right price (intrinsic value) of stocks.

But what a common man can do?

They can follow the rule proposed by Benjamin Graham in his book “The Intelligent Investor”.

These rules can help people to limit the price that must be paid to buy a stock. How?

• Step #1. Note the EPS of stock of last 7 years.
• Step #2. Calculate average EPS (7 years).
• Step #3. Calculate average EPS (1 year).
• Step #4. Fair_Price_1: 25 x EPS7Y
• Step #4. Fair_Price_2: 20 x EPS1Y

Buy stocks if its market price is between Fair Price_1 and Fair Price_2.

Rule #5. Be ready to miss the opportunity.

Common man must be ready for few compromises.

One such compromise which might come on the way is “opportunity to buy growth stocks”.

Though growth stocks are also good stocks, but they are least likely to satisfy the rule #4.

But it should not be a problem for common men (defensive investors).

In stock investing, it always pays to invest within one’s comfort zone.

Moreover, the idea of investing in “large companies” is not only to keep risks low, but also to “learn”.

Following the above said rules will allow common men to learn and also make money from stocks.

Rule #6. More detailing will help.

What we have discussed in rule #1 to #4 are core basics.

A common man cannot afford to miss these rules in picking good stocks.

But the process of stock analysis is a subject in its own. There are lengthy books written on it, but still feels incomplete.

So it is almost like impossible to write a blog post which speaks everything about stock picking.

But Benjamin Graham was a great value investor.

He has proposed few quick tips that can work like a litmus test of stocks for common men.

I personally use these tips to finalize my quick-picks.

When I do not want to spend lot of time analyzing stocks, I use these as my reliable stock screener.

* How to calculate Average EPS growth:

• Note last 10 years EPS.
• Calculate average EPS of first 3 years (AEPS_F3Y).
• Calculate average EPS of last 3 years (AEPS_L3Y).
• EPS Growth Rate: AEPS_L3 / AEPS_F3Y > 1.33.

* *How to calculate P/E Ratio:

• Note last 3 years EPS.
• Calculate average EPS of 3 years (AEPS_3Y).
• Price / AEPS_3Y = 15.

Rule #7. When to sell stocks.

For common men it is equally important to know when to sell the stock holdings.

But if it is so, why experts say to buy stocks to “hold it forever”?

Yes it is true that this can confused some people. I will try to clear the cloud.

“Holding forever” is a concept which deals more with a frame of mind of the investor than anything else.

So what actually it means by “holding forever”?

Buy such a stock which is good enough that can be held forever.

But this rule does not say that one must hold stocks forever in all circumstances.

If the market price has grown significantly, the investor must be ready to sell it.

Why to sell? To book profits and use this money to buy new stock at better price points.

What it means by significant price growth?

For me personally, significant price growth is defined as follows:

How I use this table?

Suppose I bought two Stock A and B together.

After lapse of 2 years, I found that stock A’s price grew by 1.6 times and B’s price grew by 1.4.

As A’s price growth is above the benchmark growth multiple of 1.5, I will sell it.

B’s price growth is below the benchmark growth multiple of 1.5, I will hold it.

Though this is also true that, I do not follow this rule always, but following this table helps me to make a more logical decision.

Conclusion

In the book called The Intelligent Investor, Benjamin Graham has tried to figure out a strategy for common men to pick good stocks. 

But what Benjamin Graham has highlighted in his book is not just stock picking tips.

He has described set of rules which commensurates the philosophy of a common man (defensive investor).

I will advice my readers to read Chapter 5 and Chapter 14 of The Intelligent Investor.

This book is more like a bible for value investors. 

This book highlight a very important aspect of stock investing for common men:

• Which company is good for investing?
• What is the right price at which a stock can be bought?

I feel, if a common man can even roughly answer these 2 questions, his success in stock investing is almost guaranteed.